Purchase Multiples versus trading multiples. What’s the difference?

Trading multiples represent the firm’s current market value relative to a metric.

The market value could be either that of the firm (market enterprise value) or that of equity (market value of equity).

The metric could be anything that is correlated to the firm’s ability to generate cash flows.

For example, if DropoutEdu has a market capitalization of $100 and net income of $10, we would say that its price to earnings trading multiple is 10x ($100 / $10).

Trading multiples are used in comparable companies analysis.

Purchase multiples represent the price that a company was acquired at relative to a given metric.

Again, the price could be either the market value of equity or the firm.

The metric could be anything that relates to cash flow generated.

For example, if DropoutEdu was purchased for $120M (a 20% premium) on $10 of earnings, the price to earnings purchase multiple is 12x ($120 / $10).

Purchase multiples are what we use in precedent transactions analysis.

Purchase multiples will be higher than trading multiples because companies will not sell for less than what they are valued at in the market. This would be considered a breach of the fiduciary duties of the board to do so.

A sale process must maximize shareholder value for existing investors.

Bottom-line? Purchase multiples refer to the multiples companies are sold for, whereas trading multiples refer to the current market pricing of a company.